The firm has recently won its first government contract. Consultants from Dewey, Cheatem and Howe's Messaging Department will consult with a government agency on the advertising for a new pollution reduction project. All fees charged to the government agency must be well supported. The government has examined the cost accounting system at Dewey, Cheatem and Howe and requested some refinements to the firm's system for indirect cost allocation. Specifically, the government is concerned that consultant labour hours may not be a very good allocation base and that there is potential for over-costing or cross-subsidization of services that Dewey, Cheatem and Howe provide to other customers.

b) Explain what is meant by "over-costing or cross-subsidization" in this context and how this can be related to the choice of the allocation base. [3 Marks]

The head of Accounting at Dewey, Cheatem and Howe suggests implementing an activity- based costing (ABC) system. The government agency is concerned that the first stage cost allocations in an ABC system might not be objective. The government suggests implementing a departmental cost allocation system.

c) Briefly contrast the two stages of cost allocation in an ABC system with the two stages of cost allocation in a departmental cost allocation system. Particularly, explain why the first stage cost allocation in the departmental cost allocation system may be more objective (or less subjective) than that in the ABC system. [7Marks]

Kevin Cheatem, the firm's head ofMarketing and Sales, does not like the system required by the government. Kevin claims that his department is being treated as an operating department when it is really a support department.

e) Is Kevin correct? Explain why or why not using the definitions of operating and support departments and their treatment in departmental cost allocation. [2 Marks]

Question One: [3+3+ 7 + 7 + 2 = 22 Marks] Dewey, Cheatem and Howe, Pty. Ltd. is a consulting firm. The firm is currently organized into five departments. The Accounting Department handles mostly employee payroll and customer billing. The Information Systems Department operates and maintains the firm's servers and web site, as well as the laptop and desktop computers used by the other employees. The Vision Department provides consulting services to customers related to formulation of business strategy. The Messaging Department provides consulting services to customers related to internal and external communication. The Marketing and Sales Department handles the marketing and sales needs of Dewey, Cheatem and Howe itself. The firm currently uses a job costing system with a single indirect cost pool. All indirect costs are allocated on the basis of direct consultant labour hours with normal costing. a) Explain why the firm may have chosen to implement a job costing system. Specifically explain what characteristics make an organization well suited to the use of job costing and why these may or may not be descriptive of Dewey, Cheatem and Howe. [3 Marks] After some negotiation, it is decided that departmental cost allocation and the step-down method will be used to allocate indirect costs. Accounting Department costs will be allocated first on the basis of the number of employees. Information Systems Department costs will be allocated second on the number of computers. The resulting operating department overhead cost pools will be allocated to jobs on the basis of consultant labour hours within each department. Overhead costs will be allocated to the Marketing and Sales Department but Marketing and Sales Department cost will not be allocated to jobs. The following information is provided for the departments: Department Employees Computers 5 6 Allocation Base Employees Computers None Hours Budgeted Overhead $ 800,000 $ 1,200,000 $ 900,000 $ 2,300,000 $ 1,900,000 Accounting Information Systems Marketing & Sales Vision Messaging 8 17 4 5 12 15 20 Hours 16 d) Assuming that the Messaging Department expects 40,000 of direct consultant labour hours compute the predetermined overhead rate for the Messaging Department. [7 Marks]